Monday, April 19, 2010

I posted this in response to a very good article put on the market ticker website by Karl Denninger about Clinton trying to redefine his actions in regard to financial deregulation. My point was that even though the result was disaster, by November 1999, it was already clear that the system was going to need even more money creation and financial products to keep the game going and this was going to bring another bowl of punch to the party.

I hate to disagree with some of the points in what is a fastastic writing, but by November 1999, the bubble was hopelessly inflated. The backbone of the bubble wasn't the repeal, but the GSE's FNM, FRE and Sallie Mae. The repeal only brought the crooks into the same room.

There is one thing that creates a bubble, the creation of money. Doug Noland started his Credit Bubble Bulletin around 2000 and repeatedly he went through the 1990's history of FNM and FRE pumping huge amounts of credit into the system every time the economy sneezed. Greenie had his place, but the creation of credit off collateral goes back to John Law and the Mississippi bubble. Each cycle produced more of a bang and Rubin along with Greenspan did everything they could to keep the game going.

Debt in the US has been to the point it could cause a depression for a long time, probably since the early 1990's at the latest. Greenspan did what he had to do at the time, which was ease credit excessively and create the new collateral. Except for a few days in March 1987, mortgage rates had not been down to 9% since 1978 and had resided in the 10% or higher level for over a decade. I opened a 1 man mortgage shop in 1992 to do refinances and was at least a year late. The whole country refinanced and gained immediate access to more credit. Cap rates came down and it ignited a stock market boom which money started chasing. The most marketable paper in the world, save US treasuries was FNMA and FHLMC mortgage pools.

One thing about depressions is when one starts, it is like being seen coming out of a building where a crime has occurred. You become the immediate suspect and politicians get deserved and undeserved credit for booms and busts. By 1998, anyone with economic brains knew they would need more credit to stave off a collapse from the dotbomb bubble and the huge public participtation in the market. The market participation had reached all the way into the pension funds, private and public. The entire game became keeping the bubble inflated. The repeal was merely one more step to avoid being placed at the scene of the crime.

I really don't believe many people at that time realized how crooked Wall Street was. I used to joke in front of others that when Wall Street gave a strong buy on a stock, it meant they still had some left. I knew the whole game was nonsense, in part because I have a financial education. Being Wall Street controls so much of what is taught in college, almost no one had an education on why we had Glass-Stegal in the first place. I believe in part this was due to the fact that few alive had experienced a bank run because of the false security placed on deposit insurance. People thought all this bull market was based on reality and party on and let us all get rich.

The people that did know were Summers (nephew of Paul Samuelson and son of the head of the Princeton school of economics), Robert Rubin, Sandy Weill and his student, Jamie Dimon. Under the guise of deposit insurance (Securities insurance as well)and the lack of experience in runs on banks the public didn't have enough sense to know the difference. Efficient use of credit seemed to be the name of the game, but in reality, it was how to blow a bigger bubble to keep the fake prosperity going.

By early 2001, the system was pretty much insolvent. In comes Greenspan with the means to create another bubble and Bush with tax cuts to give the stimulus. What continued was the mortgage game, a new low rate mortgage interest to give the game another dose of debt relief. Again, it was the FNM/FRE brand name, along with another bubble blower, Franklin Raines. Along comes Armando Falcon of the OFHEO in an attempt to stuff the genie back in the bottle. You can go to youtube and see videos of the attacks the Democratic black caucus launched against this man, an appointee of Bill Clinton, I am sure at the urging of Mr. Raines himself. You would have thought this man was attacking someones mother, but he was really telling the truth. In any case, this was the primary attempt to stem the mortgage bubble. At the same time, it was probably this investigation that opened the door for Wall Street and their private label game.

Now what is the game? Recently some idiot Ivy League professor recommended young people buy stock on margin. Why? They need cash to pump the next bubble. The whole series of crap in this mess has to do with what is going to be the next collateral for the next credit expansion. If this rally goes on much longer, I can see a relaxation of margin requirements on call money. The government desperately needs another money machine outside of deficit spending to keep the game going. The pension systems are bankrupt and have no hope of being funded unless the game goes on. The biggest scandals center around the fictions about owning stocks, financial instruments that have actually not done much better than inflation when valued according to dividend payout. As I have seen Karl point out, risk has a way of catching up with excess return. As long as they can inflate, the truth can be hidden. Once deflation becomes the irresistable urge, there will be a lot of models swimming naked.